Tired of all the Christmas cheer? Join me in being a bit cranky. Let's play Grinch for a minute. Yes, 'tis the season. But because I'm much more of a mutual fund hound than a mall rat, when I make my list and check it twice, it features the top five things that make me mad about funds -- both the industry and investors alike. Let's count down:
No. 5: Is the First One First-Rate? Not Always
The race is on, and there's room for only one winner: Best Performing Mutual Fund of the Year. This contest certainly makes for good copy. After all, who doesn't like a champion? And it's undeniably fun to bet on which manager will get the trophy. But should your hard-earned investment dollars follow the funds that get this year's medals?
Not necessarily. Of course, No. 1 funds can go the distance, but more often than not, it's the most volatile sector funds that snag the top prizes in any particular year. The fact that one boasts the highest return during an arbitrary 12-month period means nothing more than it has beaten its competitors during that time frame. It certainly does not mean it fits your investment goals or belongs in your portfolio.
If you need any more convincing, take a look at where last year's top three performing funds (according to
) are today.
American Heritage, No. 1 in '97, is now ranked 5,881.
MainStay Growth Opportunities, No. 2 in '97, is now 5,186th. And
Rydex Banking, No. 3 in 1997, is now down to 5,187th place.
The lesson is, if you're gonna chase this year's chart-topper, know that you may wind up in last place.
No. 4: Older Isn't Always Better
I know, I know, you don't want a fresh-faced whippersnapper, barely old enough to drive, piloting your investment vehicle. The popular perception is that highly paid young turks whose bonuses hit six digits before they see 30 are running the fund world. Some in the industry love to play up our fear that newly minted B-school grads with more arrogance than experience have control of our money. A recent ad by
spotlights a picture of a prepubescent boy, who is attired in the blue suit of an investment professional, and the warning: "The average fund manager has 3.5 years' experience. Relax, it's only your life savings we're talking about. ..."
Well, you should relax. Contrary to the caricature of a fund manager, the average age is 45, according to Morningstar. And most importantly, it seems youth is no measure of ability. Research by Morningstar shows that, during this year's downturn, the returns of funds run by managers aged 40 and under were virtually the same as those 40 and up.
The bottom line to me? The number we should care about most is our manager's returns, not his or her birth date. In the end, gray hair doesn't say much about one's ability to stay in the black.
No. 3: In This Corner ... Indomitable Index!
All too often, we consider the active vs. index debate a clear contest with only one victor. And recently, this fight has starred a real heavyweight. Yep, Indomitable Index, the muscle-bound and market-crowned
, has positively pummeled Mr. Active Manager. Fewer than 5% of all actively managed stock funds have beaten the S&P 500 over the past five years.
But does that mean you fill your portfolio with index funds alone? No. Anyone who reads this column knows I'm a big fan of indexing. I often sing their praises: namely, cost benefits and tax efficiency. And I put my money where my mouth is -- index funds make up an important part of my personal portfolio.
But why should you settle for market-like performance when there are managers out there providing market-topping returns? Yes, as the S&P continues an unprecedented run of eye-popping, double-digit years and large-caps continue to rule the day, it's getting harder to find managers who can add value. But remember, this is the type of market environment where index funds shine best. Should a small-cap rebound gather steam, you'll hear more about active funds. In that sector (and also in the international one), where stocks are less-researched, the advantages of index funds are not so clear.
Pitting index funds against their actively managed rivals just encourages the idea that only one style of investing (the prevailing one) has a place in your portfolio. So, while it may be harder to find managers capable of beating their benchmarks, it's our job as investors to look for them. This is not an either/or debate. There is room for both in your investment scheme. The index vs. managed battle is a fake fight.
No. 2: Fund Ads -- Seeing Isn't Always Believing
Get out your magnifying glass. You'll need it when reading mutual fund advertising these days. Companies are getting really creative in marketing their records.
There are the really blatant examples: As we
reported first on
Kaufmann fund made a claim that turned out not to be true. It wasn't, as some ads trumpeted, the "#1 Diversified Fund Since the Market Low of 1987." For the time period (through Sept. 30, 1998), it was actually third. Close enough, right?
Then, there's the convenient case of amnesia that most companies developed right after a disastrous third quarter. They just chose to ignore it. As we reported again here on
, many ads in November's financial magazines boasted big double-digit one-year returns. Of course you had to read the teeny-tiny admission at the bottom of the page to find out that was for the period ending June 30.
And don't forget about how new funds are using the records of other funds run previously by the same manager.
Just goes to show that mutual fund advertising should be viewed as entertainment rather than education. Past performance really doesn't tell you much about the future -- especially as fund companies represent it.
And while we're on the subject of ads -- don't you love
high-profile campaign launched this year with Peter Lynch, urging you to know your investments? A bit ironic when you consider the fact that Fidelity's fund managers are not allowed to talk about their individual holdings with the press.
No. 1: You're Paying Less? Don't Be So Sure
You'd think it would be an easy thing to measure -- the price of your mutual fund. Has it gone up or down? But you can squeeze the numbers to suit almost any argument.
This year, the
Investment Company Institute
, the industry's trade group, proclaims fund fees are down.
Really? Even the ICI admits operating expenses actually are up, even if distribution costs, such as sales loads, have declined. For the long-term investor who sticks with his funds, expense ratios are where the rubber hits the road -- that's the fee you get hit with year after year. And although many of us are voting with our feet, heading to lower-cost index funds and eschewing loads, there still are a lot of funds out there with above-average ratios and below-average performance. (For more on how to figure out if your fund fits that profile, check out my
primer on fees in the
Plus -- whatever happened to economies of scale? As a percentage of fund assets, management fees haven't fallen.
I applaud the fact that this debate is getting more notice, that we're finally starting to pay attention to what we pay. But in the end, you can really settle this issue: Ask yourself, when was the last time a mutual fund I owned
, rather than raised, its management fee?
That is still quite a rarity in the fund world.
How about you? What makes you mad about mutual funds?
Email me, and I'll include your responses in a special column next week.
Brenda Buttner's column, Under the Hood, usually appears every Thursday. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.